The Tax Man Cometh—For Your Bitcoins

Nobody knows how much tax revenue is lost to virtual-currency transactions—not even the IRS. But when has that stopped anybody?

If I write a book and sell a few million dozen copies in my local bookshop, I owe the government a cut of that income in taxes. The rules on what I fork over, and how, are pretty clear. But what if I write a book and decide to sell it online in return for bitcoins—how much do I owe the tax man then?

No one has any idea. Even though we know there are some 11 million bitcoins in circulation worldwide, nobody's sure how many users are American; so it's impossible to calculate how much money Washington is losing on transactions conducted using the anonymous digital tender. In a report out Monday, the Government Accountability Office concludes that if only bitcoin users were better informed, they'd start paying up.

"Taxpayers may be unaware that income from transactions using this type of virtual currency may be taxable," the GAO paper reads, "or if they are aware, uncertain on how to characterize it."

Try Googling "bitcoin tax," and here's what you get:

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There's an unsurprising amount of uncertainty out there about taxes and bitcoin, mainly because there's no established legal regime to govern it. That's to the detriment of bitcoin and government both: Without clearer standards, bitcoin will have a harder time attracting converts, and Washington will be forgoing a new revenue stream. Of course, there are also those who would use bitcoin as a convenient and legally ambiguous way to avoid paying taxes—hence two of the five suggested search terms above. But getting mired in the minutae of tax evasion doesn't help as much as trying to pin down the size of the overall bitcoin economy and how federal coffers might benefit from it.

In the example of the book above, I'd unquestionably owe something. But because the norms aren't clear, I'd more likely leave off reporting the bitcoin transactions until somebody told me precisely what to do. Better to file a vague return than to file one wrong and risk an audit, right?

Federal agencies have been trying to clear up some of the confusion. Earlier this year, the Treasury Department took a first step when it said it wouldn't require individuals to report large transactions (banks and other financial institutions have to do so by law, to catch suspicious activity).

Now, the Internal Revenue Service (via the GAO's report) is giving taxpayers some ad-hoc, unofficial guidance, complete with hypothetical examples.

If you're playing a massively multiplayer online game like World of Warcraft (yes, the report actually cites WoW by name) but don't convert your in-game gold to real-life dollars, you haven't made any money and you don't owe any income taxes on your gameplay.

If you trade virtual goods and services for virtual currency, you "may" have earned income, and you have to report it.

If you trade real-world goods and services for virtual currency, that might also result in taxable income.

If you earned virtual income (say, by renting out property on SecondLife) and convert those earnings into dollars, you've earned taxable income.

If you successfully mine a batch of bitcoins, that's taxable income.

Unfortunately—or fortunately, depending on your position—simply telling people that they owe isn't the same as compelling them to pay what they owe.